FTSE 350 outlook: oil & gas

Further merger & acquisition activity in the sector is possible - although it was notable that despite an attractive, very cash generative asset base, no other formal bidders were flushed out to compete against ENI for Burren, and that the private equity move for Abbot came after a period of notable share price underperformance. In the case of the mid-cap upstream oil and gas producers which would be natural bid targets, it could be that the current sky-high oil prices, which in many cases boost share values as analysts repeatedly upgrade both near-term earnings and base case reserve valuations, are making predators wait for what many will see as an inevitable cooling off.

The oil services sector is different – the outlook for the diverse spread of capabilities offered by these companies remains strong if not as explosive as last year, and the companies in question are not materially more expensive than they were last year, for example, on the basis of their forward PE ratios. New constituent AMEC, fresh from selling off underperforming businesses in other sectors and reinventing itself as an energy services player, may well feel tempted to spend its cash pile snapping up competitors, such as Wood Group, who display better margins and more exciting customer bases.

As for stand-out individual companies, Tullow Oil will continue to make news this year, proving what look to be very lucrative discoveries in Uganda and Ghana. Back in Europe, JKX should have another good year as the price it receives for its Ukrainian gas continues to rise inexorably, while it should also be presenting considerable reserve additions. We expect North Sea specialist Venture Production to also recover from a poor 2007, as UK gas prices head higher once more.

And long-time Investors Chronicle favourite BG Group should go from strength to strength. Long classed alongside ex-growth behemoths Shell and BP as an ‘integrated’ oil and gas company, its global asset footprint – including both highly prospective oil and gas upstream positions and its enviable liquefied natural gas trading business – now looks exciting enough for some analysts to claim that it should instead be recognised as a very compelling growth exploration and production (E&P) play. While expensive in forward PE ratio terms for an integrated play – although we have long-maintained it deserves this premium – it is attractively rated compared to growth E&Ps, such as Tullow. Despite massive share outperformance in the past year, it might still tempt an oil major into making a bid in 2008.